The Future of Shale Gas II – Will Russia Collapse?

In this second post on the future of shale gas, I discuss if and how growing shale gas production might foster political instability in the Middle East and the European neighborhood. I therefore turn to a recent study that has been conducted by the Hague Center for Strategic Studies (HCSS). This study on the geopolitics of shale gas finds that shale gas might have significant impact on the stability of exporting states. For two countries, so it argues, this risk is particularly high. One of them is Russia.

Rising global shale gas production will affect gas prices in Europe. Falling prices mean decreasing revenues for traditional gas exporters. Also oil exporters would be affected, if gas becomes increasingly employed in the transport sector. So what happens to states that are used to receiving big rents from their trade in fossil fuel sales? This is the question approached by the HCSS. This study, it might be said, elaborates on the ‘high success, high liberalization’/’a future in shale’ scenario that I have presented in my previous post on the future of shale gas.

Research Design

To approach their question, the HCSS authors turn to system dynamics, a computer-based approach able to build complex models of interacting variables. The study uses these models in two different stages. The first stage is aimed to explore the potential implications of the US shale gas boom on energy prices, mixes, as well as supply and demand. The authors are particularly interested in

‘extreme scenarios: scenarios which show price changes potentially outside the coping capacity of countries. Such scenarios represent a “stress test” of country stability.’

They chose worst-case scenarios in other words. With these scenarios, they turn to the second area of modeling: exporting countries stability. Since country (in)stability is the primary interest of the study, it might be interesting to have a closer look at how this issue is approached. Countries are modeled in terms of five interacting sub models: institutions, economy, population, instability, and resources.

Each of these sub models is once again differentiated internally. The economy sub model, for example, looks as follows:

As indicated by these figures, their system dynamics approach allows the authors to account for great degrees of complexity. Importantly, however, this complexity does not necessarily mean validity of findings. While system dynamics allows for keeping a lot of interactions ‘in mind’ at the same time, the substance of these interactions is based on the author’s choice rather than on some real world equivalent. Respective choices imply uncertainty. The HCSS study approaches this problem with admirable openness, when it is argued that

‘In essence, all assumptions made in the modeling process are uncertain. The extent to which the assumption is uncertain depends on the amount of consensus (e.g., in the literature) about the assumption. However, for many of these assumptions no direct literature is available and where literature is available, this does not always indicate an absence of uncertainty.’

This is particularly true when it comes to social phenomena, as in the case of modeling political stability. The authors, for example, lean towards the ‘greed’ side of a quite contingent debate about the relation between resources and conflict, often referred to but only insufficiently captured by the label of ‘greed vs. grievance’ (see, for example, the work of Humphreys). Acknowledging works such as the one discussed here, therefore, should always be sprinkled with a substantial amount of caution (also see my post on ‘Vergesst die Modelle!?’ [in German]).

Results

The overall modeling exercise makes the authors identify three factors critical to the future (in)stability of fossil fuel exporters:

The first of these is regime type. States that are neither established democracies nor autocracies – so called anocracies – are the least stable. This insight is supported by previous empirical studies, for example by those of the Polity IV Project from which the authors take their data on regime types. Although this first finding is thus not particularly surprising, it is important nevertheless.

The second critical factor that is argued to increase the risk of instability is unemployment, particularly youth unemployment. The authors mention that the amount of foreign workers might be an important buffer to avert negative effects in this regard, since these could be expelled to alleviate increases in unemployment among national workers. To be clear: Expelling foreigners is not presented as a policy recommendation. Instead the authors refer to actual cases in which Saudi Arabia has done just that.

Third, the authors highlight the importance of financial buffers as, for example, in the form of sovereign wealth funds that might help to prevent the cutting-down of subsidies.

The authors conclude:

‘Out of all countries investigated, Algeria and Russia score worst on these variables, and thus emerge as particularly vulnerable. This is not least due to both countries’ sheer addiction to resource rents misallocated in their economies.’

Discussion

The general insight of the HCSS study is that political instability could be a possible side effect of significantly expanding shale gas production. Anocracies with high unemployment and little financial buffers appear to be the most vulnerable energy exporters.

Particularly the fact that Russia is highlighted as one of the two most vulnerable states is important and worrisome news for European policy-makers. Although we are talking about worst-case scenarios here and it is therefore way too much to claim that Russia will collapse, the HCSS study is a call on Russia. It is a call to acknowledge the sometimes unpleasant truths of its own, rather unsustainable economic situation. And it suggests that it might be a good idea for the country to stop its current 20th century political demeanor and to start adapting to the world of the 21st century.

Finally, so I think, there is another state that merits more attention when it comes to the potential impacts of falling energy prices as a consequence of the ‘shale revolution’: Saudi Arabia. Although it has not been identified as critical by the HCSS study, I think there are at least three reasons suggesting that we should keep an eye on this one:

The first reason is the sheer importance of Saudi Arabia for global energy trade, matters of international security, and regional stability in the Middle East.

The second reason concerns a potential shortcoming in the HCSS study’s approach: The authors mention that they have conducted in-depth studies regarding the stability of different regime types (although these are not presented). In these studies, they claim to have taken a closer look at one country per regime type. They assume that respective findings are valid for the whole group. For anocracies their case is Russia, for autocracies they take Qatar, not Saudi Arabia. Although the latter two might share significant features, I would doubt that findings do easily travel from the very small Qatar to its big neighbor. Comparability has its limits. To point towards but one example: The Saudi fiscal break-even oil price is estimated to be almost twice as high as the one of Qatar (see here and here), making the former much more vulnerable to oil price decreases.

Third, Saudi Arabia is a (if not the) major oil exporter. In the HCSS study, oil prices are affected mainly indirect, by the potential substitution of oil demand for gas demand in the transportation sector. What does not seem to be considered is the direct effect of shale oil production. As recent studies from Harvard and PriceWaterhouseCoopers have discussed, however, there might be significant shale oil production coming up that would have more direct impact on Saudi Arabia (as well as additional impact on Russia).

Just as in the Russian case, a collapse of the Saudi regime would have tremendous impact on the world. For both cases, conducting in-depth individual case studies seem to be an important task for the future.